The Asian Development Bank is on course to achieving a development financing milestone.
In an internal memo sent to staff last week, ADB President Takehiko Nakao said donors to the bank’s Asian Development Fund have given their “formal and unanimous consent” to merge ADF with the Ordinary Capital Resources to increase the financial institution’s capacity to “do more” for the Asia-Pacific region.
Nakao first floated the proposal last year at the bank’s annual meeting in Kazakhstan. The approach entails “leveraging” available resources to be able to do more without asking for additional donor money. This was the ADB chief’s innovative solution to a problem he faced when he took the helm in April 2013: How to make the Manila-based institution a much more relevant player in the region’s development.
“Unless we have a certain lending capacity, ADB's relevance will be limited. So from the beginning of my presidency, we started thinking [of] how we can increase our lending capacity,” Nakao told Devex in an exclusive interview. “Unless we increase our lending capacity, which is in line with the infrastructure planning and the increasing size of the Asian economy, we cannot remain relevant to Asia.”
If approved by the bank’s board of governors, ADB’s two main financial instruments will be merged by January 2017. With the addition of ADF’s more than $34 billion envelope, the merge will triple the bank’s current OCR equity from $18 billion to $53 billion. It will also increase the bank’s lending operations more than 38 percent, from $13 billion to $18 billion — which basically means more development funds can be loaned to developing member countries.
READ MORE: ADB funds merger — what it means for stakeholders
Using leverage
The brilliance of the plan, according to Nakao, lies in the concept of “leveraging,” a common finance term which simply means using something to maximum advantage. By merging ADF, a trust fund dedicated to loans and grants for the poorest countries in the region, and the OCR, which funds the bank’s general lending operations and come from contributions from shareholder partners, ADB’s ability to leverage borrowed money increases.
With the present structure, only OCR funds can be leveraged. ADF only acts like a debit card, meaning it can only lend what is in the fund. The bank’s ADF loans portfolio totals $30 billion — the rest are doled out as grants — and if it wants to increase lending, it would have to ask more money from ADF donors. This is not something that can be done quickly, however, given the fund’s four-year replenishment cycle.
When the proposal was first discussed internally in August 2013, Nakao said the plan was to return ADF contributions to donors, which would then forward the amount to the OCR pool. ADB, for instance, would have to give back 37.9 percent of its ADF portfolio — $12 billion — to Japan and then ask the Asian donor to contribute the same amount to the OCR.
But Nakao realized there are two problems with that approach.
OCR contributions depend on a donor country’s voting share at the bank, which means any additional contributions would have to take that into account. Ignoring the voting share would change the bank’s whole capital structure. Further, any additional contributions would require approval from that country’s parliament or congress, and “it could take a lot of time.”
“What I proposed is we can just use donors’ contribution to ADF in a more innovative and productive manner by moving the equity of ADF resources to OCR reserves … so that we can start using the existing equity of ADF as [additional] leverage,” he explained. “We can strengthen our support to poor countries, and we can also increase our capacity and readiness to support other countries when there is a need. Also, we can alleviate the burden to donor countries by using leverage for the future [instead of asking for more money].”
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The ADB chief added the rise of middle-income economies among its developing country members was a factor as well. More countries are expected to move up to middle-income status over the next few years, thereby shrinking the client base for ADF — a natural development progression that the bank welcomes and is adjusting to.
Repercussions to stakeholders
One of the biggest concerns when the proposal was announced in May last year was that it might discriminate against poor countries. The assumption then was that the ADF — and its low interest rates and lengthy payment periods — will cease to exist after the merger.
But Indu Bhushan, the bank’s strategy and policy director general, explained to Devex that there wouldn’t be any drastic change in terms of lending conditions — including interest rates — as it is just a “name change.”
Once the financial instruments are merged, ADF loans will be referred to as “concessional OCR loans,” but the flat 1.5 percent interest rate will be kept. They will also have the “same tenure.” The grant component, which comprises 10 percent of the ADF money pool, will remain unchanged as well.
Instead of being at a disadvantage, poorer countries may yield more benefits, Nakao said, as they can now get more OCR funds at the same concessional lending conditions.
“Graduating countries have a secure access to the nonconcessional lending from OCR,” the ADB chief noted, “so poor countries should be happy and donor burden can be alleviated.”
Nakao further explained that for other middle-income countries “who are not regarded [as] ADF-eligible countries, they can also expect more lending when they really need money.” The bank can now also increase private sector operations and improve its readiness to support disaster-affected countries. There will be no changes to the governance structure as well.
The ADB official hopes this “landmark financial innovation” can jump-start a revolution in the development finance landscape, particularly at other multilateral development institutions.
“This approach of supporting leverage for supporting poor countries would give a lot of stimulus to those assistance institutions,” Nakao concluded. “There are many approaches to do this but at least I think our approach will give a kind of incentive to start thinking how to better use the existing resources more efficiently.”
Can the Asian Development Bank’s “landmark financial innovation” be easily replicated or adapted at other multilateral development banks? Let us know by leaving a comment below.
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